An independent contractor is a worker who contracts with individuals or entities to provide services and is distinct from an employee. When workers are classified as independent contractors, they are not entitled to the benefits and protections afforded to employees. If an employer misclassifies workers as independent contractors rather than employees, even if by accident, there can be severe penalties.
Misclassification refers to an employer's improper treatment of a worker as a contractor for tax and legal purposes. Misclassification deprives workers of legal benefits and protections and denies revenue to state and federal governments. Thus, multiple governmental agencies enforce regulations governing the classification of employees.
The Department of Labor (DOL), the National Labor Relations Board (NLRB), and the Internal Revenue Service (IRS) each use their own legal tests to determine whether a worker is considered an independent contractor or employee. The tests apply a number of overlapping factors that drive this determination, such as whether:
- The employer has a large degree of control over the work;
- Special skills or training is required for the work;
- The employer provides the tools needed for the work;
- The employee has an opportunity for profit or loss;
- The duration of the working relationship;
- The work is an integral part of the employer's business; and
- The method of payment is by time or by task.
Each agency applies its own test with different combinations of factors, placing greater importance on some factors over others. However, the DOL recently issued a proposed rule which requires employers to use a totality-of-the-circumstances analysis, weighing all of the factors together. The proposed rule focuses on whether the worker is economically dependent upon the employer for work or is in business for themselves. The proposed rule also requires a closer analysis of worker purchases for tools and equipment to determine whether such investments are truly entrepreneurial in nature. The DOL has extended the comment period for the proposed rule until December 13, 2022.
Misclassifying workers may result in expensive penalties to the employer. The IRS may assess a variety of penalties, including: (1) a $50 fine for each unfiled Form W-2; (2) payment of unemployment, Social Security, Medicare, and income taxes; and (3) up to $1,000 in fines per misclassified worker and one year of prison time if the IRS suspects intentional misconduct. Employers also may be responsible for back pay, overtime pay, and payment of benefits otherwise available to misclassified employees (including pension, health insurance, paid leave, worker's compensation premiums, and severance pay).
Employers should closely review their relationships and contracts with independent contractors and seek legal counsel when engaging with contractors.
Have questions about how you should classify your workers? Please give us a call at 765.423.7900 or send us an email at info@gutweinlaw.com.
